Mastering Your Emotions for Smarter Financial Decisions

In the realm of finance, emotions and unconscious biases often play a larger role than we realise. This article delves into their impact on financial decisions and offers strategies for more rational decision-making.

The decisions we make have the potential to steer our lives in vastly different directions. Good decisions can profoundly improve our situation in life, while a poor decision can have unpleasant consequences. Examining how emotions influence your thoughts and actions can equip you to make well-grounded decisions, including those relating to your financial affairs.

The Powerful Influence of Emotion on Financial Decisions

Even if you think your decisions are based on logic and common sense, the truth is, our financial decisions are frequently driven by emotion, often more than we realise.

Research by Nobel laureate psychologist Daniel Kahneman reveals that emotions contribute to approximately 90% of our decisions, leaving logic to account for just about 10%.ⁱ Kahneman’s position was that human reason left to its own devices is subject to emotional biases, so if we want to make better decisions in our personal lives, we need to be aware of these biases.

Awareness: Your Secret Weapon in Financial Planning

Given that emotions and unconscious bias can cloud our judgement, some self-examination can help ensure that you are making the best decisions.

Studies have demonstrated that individuals who can accurately identify their emotions tend to make superior decisions.ⁱⁱ This is known as “making conscious the unconscious” and it involves examining your emotions and beliefs to so you can better understand their influence on you.

The goal isn’t to be emotionless – it’s important to ‘feel’. The key is to understand how your feelings are impacting your choices. A good example might be how feeling particularly confident may cause you to take on more risk associated with an investment than you would ordinarily be comfortable with.

Hit ‘Pause’: The Power of Patience in Financial Decision-Making

Once you’ve identified how you are feeling, it’s time to hit ‘pause’ for a moment. Decisions driven by the unconscious mind generally happen faster than those we think about. Not reacting immediately gives you a chance to observe any biases without being controlled by them, allowing for improved and more objective decision-making.

Even taking a couple of deep breaths before responding to that email that’s made you angry will help you respond in a more rational way. Just think about how scammers use people’s tendency to react to fear, without thinking too much about what they are being asked to do.

Recognising Patterns: Learning from Your Financial History

Taking time to think also allows you to reflect on past decisions and the result of those decisions. For example, reflecting on past investment choices that were unduly influenced by a fear of missing out, can help individuals better manage future decisions.

Your subconscious can cause you to cling to outdated views you hold of yourself – and these can drive poor decisions. A good example is people managing their wealth according to how they did things when they first started out, rather than adapting their behaviours to their changed financial circumstances.

Getting Rational: The Path to Objective Financial Decisions

Once you have acknowledged the part that your subconscious and past patterns of behaviour play in decision making, it’s time to get rational. Rational decision-making involves taking emotion and any unconscious biases out of making decisions and applying logical steps to work towards a solution. The process involves a series of steps that generally encompass: identifying a problem or opportunity then gathering the relevant information, developing options, evaluating alternatives, then finally selecting a preferred alternative on the basis of the research you’ve done.

It’s also a good idea to run important decisions by a third party who is not so emotionally involved. For your financial decisions that’s where we come in. While we respect and acknowledge how you feel in relation to your financial life, we can provide factual information and challenge any notions that no longer serve you, to help you make the best possible decisions regarding your finances.

i https://www.jstor.org/stable/1914185
ii https://www.ncbi.nlm.nih.gov/pmc/articles/PMC2361392/

This article is intended as an information source only and to provide general information only. The comments, examples, words and extracts from legislation and other sources in this publication do not constitute legal advice, financial or tax advice and should not be relied upon as such. All readers should seek advice from a professional adviser regarding the application of any of the comments in this article to their particular situation.